DOCUMENT OF THE EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT STRATEGY FOR LITHUANIA

Transcription

1 DOCUMENT OF THE EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT STRATEGY FOR LITHUANIA As approved by the Board of Directors at its meeting on 13 November 2012

2 TABLE OF CONTENTS EXECUTIVE SUMMARY THE BANK S EXPERIENCE AND PORTFOLIO Overview of Bank activities to date Implementation of the previous country strategy Transition impact of the Bank s portfolio and lessons learned OPERATIONAL ENVIRONMENT Political context Macroeconomic context Structural reform context Business environment Social context Legal context Energy efficiency and climate change context STRATEGIC ORIENTATIONS Transition challenges Bank s priorities for the strategy period Sectoral challenges and the Bank s operational response Environmental and social implications of the Bank s proposed activities ACCESS TO CAPITAL Private sources of capital MDB finance and cooperation with other IFIs and multilateral donors ANNEXES ANNEX 1 POLITICAL ASSESSMENT ANNEX 2 ASSESSMENT OF TRANSITION CHALLENGES ANNEX 3 LEGAL TRANSITION ANNEX 4 SELECTED ECONOMIC INDICATORS ANNEX 5 GENDER EQUALITY i

3 EXECUTIVE SUMMARY The Republic of Lithuania is committed to and applying the principles of multiparty democracy, pluralism and market economics in accordance with Article 1 of the Agreement Establishing the Bank. Lithuania is an advanced transition country that has made substantial progress in political and economic reforms since the restoration of independence in An EU member state since 2004, Lithuania has implemented the body of EU market legislation and regulation and integrated effectively into pan-european structures. As a result, Lithuania has benefited from sustained capital inflows and strong trade links with the rest of the EU. Despite successful market-oriented and democratic reforms, Lithuania was hit hard by the global financial crisis of The crisis revealed a number of remaining reform challenges, particularly in the areas of competitiveness and public and corporate governance. In response, the government revived its structural reform efforts, articulated in the National Reform Programme updated in April The programme identifies Lithuania s obstacles to growth: imbalances in the public finances, insufficient competitiveness and productivity, problems in the business environment, underdeveloped infrastructure, and high unemployment. This recovery from the recession of has now entered its third year, and growth has been well balanced between external demand and domestic private consumption, although growth weakened toward the end of 2011 following the disruptions in the Eurozone. Nevertheless, there have been gains in competitiveness over recent years, underlined by the largest reduction in real unit labour costs relative to 2007 of all new EU member states. Fixed capital investment has also recovered well. Unemployment has fallen and, together with encouraging wage trends, explains the relatively resilient consumption growth throughout the last year. Having remained outside an IMF programme, the government adopted a moderate fiscal consolidation package in The deficit remained precariously high in both 2010 and 2011 and the country witnessed a rapid deterioration in its public debt indicators, with public debt now projected to continue climbing to a peak this year at just over 40 per cent of GDP. The authorities seek to comply with Maastricht criteria from this year and an ambitious target for the budget deficit of three per cent this year has been maintained, despite somewhat lower growth expectations. In the light of ongoing concerns by private investors over governance issues and competition from the informal sector the government has sought to ensure a more level playing field. The government continues to hold stakes in state-owned companies, importantly in the energy, transportation and postal services sectors. For these companies there has been some progress in improving transparency and strategic planning. A full separation of regulatory functions from the ministries which manage the ownership stakes in these enterprises remains the government s ambition. The national reform programme also emphasises the need to raise competitiveness. The programme targets technology intensive production through stimulating research and development, notwithstanding the constraints in public funds and private equity. 2

4 The programme recognises the long term nature of many of these plans, for instance in raising participation in the labour market, improving standards in education and training or in the development of clusters of innovative technologies. The relatively sound skills base in the country should provide a good foundation to develop these industries further. The key remaining transition challenges in Lithuania are to reduce the energy intensity of the economy, particularly in the transport and residential sectors; build more effective institutions supporting the development of private equity to enhance financial intermediation to enterprises and foster the growth of risk capital; and deepen the market structure in the energy and infrastructure sectors and non-bank financial institutions. Strategic directions As Lithuania is an advanced transition country, the EBRD s activities at present are limited and will remain focused on a small number of priorities, in line with the expected graduation of the country by the end of the current EBRD medium term strategy period in The Bank will provide support in the core areas where transition challenges remain, recovery from the financial crisis still requires support, and where reforms can be accelerated to improve the country s business environment and enhance competitiveness. In light of Lithuania s remaining transition challenges, and building on the Government s National Reform Programme, the Bank has identified the following key strategic directions: Supporting investments in renewable energy and energy efficiency: The Bank will continue to focus on promoting and financing new renewable energy generation and improving energy efficiency particularly in municipal and industrial sectors. Improving the competitiveness of the export sector: The Bank will promote cross-border investments by Lithuanian companies elsewhere in EBRD s countries of operations and support export-oriented enterprises with a focus on investments in advanced technologies. Investments in regional equity or mezzanine funds will also be considered. Support strengthening of local banks: EBRD will continue its support of the local banking sector, focusing on strengthening sector stability and promoting consolidation. Policy dialogue: The Bank will conduct policy dialogue with the Lithuanian authorities to support improvements in corporate governance in the financial and public sectors. 3

5 1. THE BANK S EXPERIENCE AND PORTFOLIO 1.1. Overview of Bank activities to date EBRD has signed 78 operations in Lithuania to date with a net cumulative business volume of 603 million and a total project value of 1,932 million. The investments have been fairly evenly distributed across sectors: approximately 26 per cent of the Bank s investments have been in the Financial Institutions sector, 18 per cent in Power and Energy, 29 per cent in Industry, Commerce and Agribusiness and 27 per cent in Infrastructure. Table 1. Portfolio in Lithuania as of 30 April 2012 SECTOR Amount in EUR million NET CUMULATIVE BUSINESS VOLUME Number of Projects Total Project Costs EBRD signed EBRD % of Total Number of Projects CURRENT PORTFOLIO STOCK Portfolio % of Portfolio Operating Assets % of Operating Assets Power and Energy % % % Financial Institutions % % % Bank Equity % % % Bank Lending % % % Insurance and Financial Services % 0 0 0% 0 0% Industry, Commerce and Agribusiness % % % Agribusiness % 0 0 0% 0 0% Equity Funds 20 *) % 16 *) % % Property & Tourism % % 4.3 2% Manufacturing & Services % 0 0 0% 0 Telecom, Informatics, Media % % 6.5 3% Infrastructure % % % Municipal & Environmental Infrastructure % % % Transport % % % TOTAL % % % NOTE *): Equity Funds includes various regional funds with allocations to Lithuania Table 2: Portfolio Development in Lithuania Amount in EUR million April Development over Net Cumulative Business Volume (end 2008 vs end March 2012) 22% Cumulative Number of Operations % Current Portfolio Stock % Number of Operations % Operating Assets % % Undrawn 14% 24% 19% 13% (cumulative March 2012) Annual Business Volume million EUR Number of Operations projects Gross Disbursements million EUR Annual Cancellations million EUR Active Pipeline Stock Private Sector Share (% Portfolio) 56% 62% 51% 49% Non Sovereign (% Portfolio) 92% 94% 96% 97% The Bank s cumulative business volume increased during the previous strategy period by 22 per cent, with 130 million invested in 10 projects over that three-year period. 4

6 The portfolio and operating assets have increased by 44 and 48 per cent respectively following a sizable investment in early As a result of projects invested in during the previous strategy period the share of energy projects in the portfolio has reached 38 per cent. Chart 1: Sector Split of Business Volume in Lithuania in Implementation of the previous country strategy The previous country strategy for Lithuania was approved in September 2009 and targeted the following operational objectives: Foster commercial banks continued lending to the corporate sector, particularly to SMEs, by providing long term debt and equity to financial institutions and invest in mezzanine and equity funds to ensure availability of financing. Promote investments in renewable energy and to improve energy efficiency as well as energy security also through supporting the development of power links. Provide higher-risk products such as equity for local corporations to fund their growth and improvements in competitiveness as well as to strengthen their corporate governance. Particular attention will be paid to local companies investments in the context of cross-border expansion. Where appropriate support municipalities through public-private partnerships and through financial institutions to ensure commercial co-financing for EU funded projects. Proactive review and management of the Bank s portfolio to maintain its high quality. Prior to 2009 the business volumes in Lithuania had been very low and finding opportunities where the Bank would be additional and transitional had become challenging. As a result of the financial crisis the situation changed and the EBRD was able to provide support particularly to the financial and energy sectors. In October 2009, as part of crisis response, the Bank signed a convertible loan of 30 million for Siauliu Bankas to facilitate its lending to the Lithuanian SME sector and the bank s co-financing of investments supported by EU and Lithuanian government programmes. Siauliu Bankas has been a long standing EBRD client, and as a local bank outside the capital, is ideally placed to reach SME clients. Support to Siauliu 5

7 during the crisis has been particularly important given the difficulty of the international funding market. During the previous strategy period EBRD has signed 5 investments in regional equity funds covering Lithuania. No investments out of these have yet materialised in Lithuania, but out of two earlier equity fund investments (both signed in 2007) two investments have been made: a 4.9 million investment in Kelprojektas, a road construction company and a 7.8 million investment in Central European Airport Services. In 2010 the Bank signed a 71 million loan to Lietuvos Elektrine (since merged into Lietuvos Energija) to finance the upgrade and modernisation of its power generation capacity at the same time increasing the capacity by approximately 150MW. A modern and efficient power plant in Lithuania will facilitate the deregulation of the Lithuanian power sector and the formation of an open regional Baltic power market. The project is co-financed by the International Ignalina Decommissioning Support Fund and a group of commercial banks. During the previous strategy period a new law on renewable energy was being developed and this came into force in May As a result some uncertainty regarding the legal framework prevailed and not many investments in renewable energy generation were made; however through its Estonian investee company, Freenergy, the EBRD has supported three investments in wind parks in Lithuania with 26 MW of new capacity being operational and another 40MW under construction. In May 2011 the EBRD signed a loan of 19.5 million and a subordinated loan of 6.5 million with a Lithuanian wood processing company, VMG, to support a crossborder investment in Belarus. This was followed in early 2012 by a loan of 5 million for SBA s Belarusian subsidiary. This investment will expand the company s furniture production and is an illustration of how local companies can gain scale by expanding regionally. As part of the crisis response the Bank took a very proactive approach also in monitoring of the portfolio and has been able to maintain its high quality during the crisis. The Bank conducted policy dialogue in relation to the new postal law to be implemented in 2013 and in support of the authorities aim to develop public-private partnerships (PPPs) in Lithuania through assisting in the development of contract templates to smooth the processes. Following the collapse of Snoras Bankas in late EBRD engaged in banking sector related policy dialogue and on means to promote stability and encourage consolidation Transition impact of the Bank s portfolio and lessons learned Since 2009, when the previous strategy was adopted, only two signed Lithuanian (excluding regional) projects were transition-rated by the Bank. The project in financial sector was assessed with Good transition potential, and another project in energy sector with Satisfactory potential. The former is the crisis response project with the main transition objective of supporting the commercial bank at a difficult time of financing and the government s efforts to expand SME lending has Good transition potential. The Satisfactory-rated investment in power and energy sector 6

8 does have positive transition impact of increasing the electricity generation efficiency and upgrading the environmental standards; the impact however is constrained by the state-owned nature of the client. The projects in the Lithuanian portfolio are performing well in terms of achieving their envisaged transition impact. All eleven operations in the Bank s portfolio 1 are as of end-may 2012 on track to achieving their transition potential. Four projects in the country s portfolio have a rank 2 in the range from 1 to 3 in other words, they have mostly achieved their desired transition impact. The remaining seven operations are currently ranked 4 or 6, which indicates that they are on the way to achieving their transition objectives. The average rank of Lithuania s active portfolio is equal to 4.09, which is similar to the average rank for all projects in the Bank and is better than the institutional target of Two transition-rated operations which were active in Lithuania during the previous strategy period ( ) were fully repaid and are now completed, and as such no longer form part of the Bank s portfolio. Both also largely achieved their desired transition objectives. 2. OPERATIONAL ENVIRONMENT 2.1. Political context The coalition government headed by PM Andrius Kubilius weathered the economic crises of 2009 and 2011 with a high degree of unity and policy effectiveness. Despite the effective crisis management, parliamentary elections on 14 and 28 October 2012 resulted in a significant decline in support for PM Kubilius Homeland Union- Lithuania Christian Democrats (TS-LKD) and a victory for two opposition parties. TS-LKD s seat share fell from 45 to 33, while the centre-left Social Democrats increased their share of seats to 38 (of a total of 141) and the populist Labour Party came in third place with 29 seats. The Order and Justice party of impeached former President Rolandas Paksas received 11 mandates. The three parties look likely to form a new coalition government with a comfortable majority of 78 seats, although ongoing police investigations into alleged election fraud might make such a coalition untenable. If confirmed by the president, the new coalition is likely to adopt a more populist, anti-austerity stance, including changes to a number of spending and tax policies. It has also promised to scrap existing plans to build a new pan-baltic nuclear power plant, as supported by two-thirds of Lithuanians in a national referendum concurrent with the first round of the election. Corruption and poor public governance, which have affected two of the three proposed coalition parties, is likely to become an issue of concern once again. Against this backdrop, the electorate s trust in all political parties remains low. Nevertheless, despite important nuances in spending programmes 1 i.e., all active operations more than six months since signing and which have been monitored for their transition impact at least once. 2 Rank is a combination of the relevant rating for transition impact potential and risks to transition impact. Expected transition of operations is usually monitored once a year and is ranked numerically from 1 to 8, with 1 to 3 indicating that impact has been mostly realised impact, 3 to 6 that the project is generally on track to achieve its transition objectives, and 7 to 8 that the project has had minimum transition impact or excessive risks. 7

9 and a generally more euro-sceptic perspective, the new government is likely to maintain the same broad reform agenda as the Kubilius-led coalition during the next Strategy period. See Annex 1 for a more detailed assessment of the political context Macroeconomic context Lithuania in 2011 experienced the second fastest expansion in the EU. Given its strong position in a number of export markets and improved competitiveness, real GDP grew by 5.9 per cent in 2011, and is forecast to grow by about 2.8 per cent this year. Competitiveness indicators and a broad product mix should allow Lithuania to continue to gain market shares, and see trend growth of above 3 per cent over the coming years. This recovery from the recession of has been remarkably balanced between external demand and domestic private consumption and now enters its third year. Along with other countries in the region Lithuania showed a clear weakening in growth towards the end of 2011 following the disruptions in the Eurozone since mid Nevertheless, there have been gains in competitiveness over recent years, underlined by largest reduction in real unit labour costs relative to 2007 of all new EU member states, and the country is relatively well positioned in a number of technology-intensive export markets. About 24 per cent of exports are directed to Russia and Poland which have grown strongly, and vis-à-vis these countries Lithuania s currency peg to the depreciating euro has also gained a price advantage. In 2011 exports stood 25 per cent above the level of the pre-crisis year On the back of recovering corporate profits and regaining flows in credit to the corporate sector fixed capital investment has also recovered, showing a growth of 17 per cent last year. Unemployment has dropped markedly (though is still at just under 14 per cent in mid- 2012) and, together with encouraging wage trends, explains the relatively resilient consumption growth throughout the last year. Despite the excessive growth in credit before the crisis, Lithuania s household debt is among the lowest in the EU. Nevertheless, households are still reducing their debt levels, with credit redemptions of about 1.2 per cent of GDP last year. Having remained outside an IMF programme, the government adopted a moderate fiscal consolidation package in 2009, including through a VAT increases. The deficit remained precariously high in both 2010 and 2011, although it has been trending down from 9.4 per cent of GDP in 2009 to 5.5 per cent in As a result of this large deficit, Lithuania witnessed a rapid deterioration in its public debt indicators, with public debt now projected to continue climbing to a peak this year at just over 40 per cent of GDP. The authorities seek to comply with Maastricht criteria from this year, and an ambitious target for the budget deficit of 3 per cent this year has been maintained, despite somewhat lower growth expectations. These plans were backed up last year through a four per cent across-the-board spending cut. There has been some 8

10 ambivalence in targeting indirect taxes and administered prices at meeting the inflation target. See Annex 5 for a table with Selected Economic Indicators Structural reform context Amidst a sustained recovery from the deep economic crisis of 2009 Lithuania has revived its efforts in structural reforms. Most of its policy ambitions have been articulated under the National Reform Programme which was updated in April 2012, and assessed by the EU Council, based on a proposal by the Commission. The updated programme identifies the well-known obstacles to growth principally, imbalances in the public finances, insufficient competitiveness and productivity, problems in the business environment, underdeveloped infrastructure, and high unemployment. In the light of ongoing concerns by private investors over governance issues and competition from the informal sector the government has sought to ensure a more level playing field, and the reduction in the flat rate corporate tax in 2010 should support this aim. The government continues to hold numerous stakes in state-owned companies, importantly in the energy, transportation and postal services sectors. For these companies there has been some progress in improving transparency and strategic planning. The Reform Programme underlines the fact that this sector has shown good revenue growth and has returned to profit in A full separation of regulatory functions from the ministries which also manage the ownership stakes in these enterprises remains the government s ambition. The national reform programme emphasises the need to raise competitiveness. The programme targets technology intensive production through stimulating research and development, notwithstanding the constraints in public funds and private equity. The programme recognises the long term nature of many of these plans, for instance in raising participation in the labour market, improving standards in education and training or in the development of clusters of innovative technologies. The relatively sound skills base in the country should provide a good basis to develop these industries further. The energy sector remains a focus of the government s work. In 2012 parliament adopted the Energy Independence Strategy, which aims at expanding generation capacity, raising energy efficiency and securing supplies through the connection to markets in continental Europe. In line with these plans some consolidation in the domestic electricity operators has been implemented. The need to diversify sources of energy supply and enhance energy security has emerged as a major challenge following the closure of the Ignalina nuclear power plant and the uncertainty over the reliability of gas supplies from Russia, from where all gas is imported. Agreement on the construction of a floating LNG terminal in the port of Klaipeda bodes well for this strategy. Plans for a new nuclear power plant have been finalised with international investors, though remain controversial domestically. In the financial sector, the authorities are keen to put in place a regulatory framework that will prevent the excesses of the previous lending boom. The personal bankruptcy law was streamlined, and a regulation for responsible lending that is to prevent the reemergence of unsustainable credit and house price development has been introduced. 9

11 The failure of a mid-sized local bank (Bank Snoras) in November 2011 motivated greater government attention to governance and business models of local banks. The bank s failure was due to an isolated case of fraud, though it briefly eroded depositor confidence in the viability of the few remaining locally owned banks. All retail deposits of Snoras were honoured, though as a result of the closure of the bank the public sector has assumed a liability of at least 2.5 per cent of GDP in excess of the assets in the deposit insurance fund. Following the financial crisis, closer cooperation with Nordic and other Baltic supervisors is being established, including through presumptions for burden sharing. See Annex 2 for a detailed assessment of the remaining sector transition challenges Business environment Lithuania s business environment is among the best in the transition region. The World Bank s Doing Business 2013 survey ranks Lithuania 27th worldwide, down from 26th in 2012 and the lowest of the three Baltic states but still relatively high when compared to other CEB countries. Over the past year progress was made in areas such as starting a business, for which online registration for limited liability companies was implemented and the notarisation requirement for incorporation documents was eliminated, reducing start up times and costs. However, Lithuania s score on starting a business (ranked 107 out of 185) continues to lag well behind the regional average. Resolving insolvency cases was simplified by establishing which cases are taken to the bankruptcy court, tightening the time frame for decisions on appeals, abolishing the court s obligation to individually notify creditors and other stakeholders about restructuring proceedings and setting new time limits for creditors to file claims. Improvements were also noted to the time and cost burdens for export and import procedures. Lithuania scores particularly well in terms of registering property (ranked 5th globally) that involves only three procedures, takes three days and costs on average 0.8 per cent of the property value. Corruption remains an issue in Lithuania: Transparency International s 2011 Corruption Perceptions Index ranks Lithuania 50 th globally and 22 nd amongst 30 European countries. According to the World Bank s estimates, the shadow economy accounted for 30 per cent of GDP in 2007, the highest ratio among all CEB countries. The 2009 EBRD/World Bank Business Environment and Enterprise Survey identified high tax rates as the largest obstacle to doing business, followed by competition with the informal sector, limited access to finance and political instability. According to the government s National Reform Programme approved by the government in April 2012, the key measures for improving the business environment are now focused on reducing the administrative burden on firms, ensuring the availability of financial resources and promoting free and fair competition Social context Lithuania has experienced a significant advance in living standards since the beginning of transition. Over the last decade the UN Human Development Index (a measure of general wellbeing) has increased on average by 0.7 per cent a year, an above average pace among CEB countries. However the country ranks at only 40th 10

12 place worldwide in 2011, the second lowest rank in the CEB region. Most notably, Lithuania lags behind in terms of life expectancy with 72.2 years at birth. Also, the gap between the expected duration of schooling and years of actual school attendance is the highest across all CEB countries. According to Eurostat, more than 20 per cent of population was at risk of poverty in 2010, one of the highest shares in the CEB region and significantly above the EU average. Inequality is a serious social issue: the Gini coefficient of 36.9 is the highest in the EU. Unemployment rates in Lithuania increased notably over last few years, peaking at 18.3 per cent in July The ratio has shown a strong downward trend but still remains high at 13.7 per cent, in particular given youth unemployment at 27.7 per cent. The employment rate at around 61 per cent is significantly below the EU-wide target of 75 per cent, a common issue throughout the CEB region. Education expenditure in Lithuania is at 5.6 per cent of GDP, among the highest in the CEB region. The mean years of schooling in 2010 was 10.9, below the OECD average of 11.4 years. In the 2009 OECD Programme for International Student Assessment, the country ranked 40th (lowest CEB rank) out of 66 with below OECD-average rating in all categories. The European Commission s 2012 Ageing Report suggests that over the next fifty years Lithuania s total population will decrease by 19.6 per cent with a parallel drop in the total workforce of almost 36 per cent. As a result, the dependency ratio (population aged 0-14 plus 65 and over relative to the workforce aged 15-64) is expected to increase from 45 to 82 per cent between 2010 and Total health care expenditures stood at about 7.5 per cent of GDP in 2009 (highest ratio among the Baltics), of which public health spending was about 5.5 per cent. Population ageing and cost pressures will rapidly push up expenditures on health and old-age care over the next decades unless mitigating measures are taken Legal context The Bank s recent assessments of laws in the region show that Lithuania has an advanced set of commercial and financial laws when compared to other transition countries where the Bank operates. There are nevertheless some areas of improvement such as the insolvency regulation where further efforts are needed to approximate international standards of best practice. Although system for taking security is functioning well some modifications would also be welcome to facilitate using fluctuating pools of assets as collateral and using a general description of debt in security documents. Pursuant to the new National Energy Independence Strategy adopted by parliament, Lithuania needs to promote competitiveness by increasing interconnectedness with European electricity and gas networks. Electrical Grid Synchronisation Law dated 12 June 2012 complies with the EU's third energy package and will allow the country to connect to the Western European power network by With respect to renewable energy (RES), while adequate financial incentives are in place to overcome cost barriers to market entry, there has been little progress towards eliminating non-cost barriers to large-scale RES development. Finally, while the government has made 11

13 some progress in improving the energy efficiency of buildings, disincentives should be examined and reduced to the extent possible. The public-private partnership (PPP) legislation is of high quality. However, further obstacles for the wider use of PPPs include the relatively small size of the projects, the role of the Central PPP Unit being limited to basically promotion of PPPs, and lack of competence and assistance for preparation and implementation of PPPs at the level of smaller municipalities. The Ministry of Finance is currently implementing a PPP Promotion Project in cooperation with the Central PPP Unit, financed from EU funds. One of the main aims of this project is to increase the competence of public sector workers (including from municipalities) in PPP structuring and implementation. See Annex 3 for a more detailed assessment of the legal environment Energy efficiency and climate change context Lithuania s primary energy intensity, between 1995 and 2009, fell by 4.5 per cent per year. Also CO2 intensity fell slightly faster than energy intensity by 5.4 per cent/year 3. That large improvement is linked to a drop in industrial energy intensity per cent per year between 1995 and However, primary energy intensity in Lithuania still remains 40 per cent above the EU average. Following accession to the EU in 2004, Lithuania began to rapidly liberalise its energy market. One of the main energy challenges for the country is that it remains heavily dependent on gas imports mainly coming from the Russian Federation. The structure of Lithuania s industrial energy consumption changed dramatically between 1995 and Energy-intensive industries account for half of total industrial energy consumption, compared with 46 per cent in The chemical industry is the largest consumer with 30 per cent of the total (15 per cent in 1995), followed by the non-metallic minerals industry (16 per cent compared with 27 per cent in 1995). The share of the pulp and paper industry is smaller, and accounts for just 3 per cent of industrial energy consumption. An Energy Efficiency Action Plan for Lithuania was adopted in July 2007 and revised in December It sets a final energy consumption savings target of 4.7 TWh between 2008 and 2016, 37 per cent of which is to be achieved in the household sector, 10 per cent in transport, 8 per cent in industry, 5 per cent in the commercialpublic sector and 40 per cent through cross-sectoral measures. Those cross-sectoral measures include building regulations, voluntary agreements with energy companies on energy efficiency (individual meters in households and industry), tax rebates and information campaigns. On the power sector, the average efficiency of power generation is low (33 per cent in 2009), due to the dominant share of nuclear power in the electricity mix. The efficiency rate of thermal power plants is also low (24 per cent, compared with the EU 3 Lithuania: Energy efficiency report: Country reports 12

14 average of 39 per cent), although it is increasing following the commissioning of gasfired facilities. Lithuania is not considered to be highly vulnerable to the impacts of climate change. However any future EBRD investments in coastal infrastructure should take into consideration the implications of sea-level rise that may occur as a consequence of climate change. Finally, the Law on Renewable Energy Sources (2011) aims to increase the share of renewables in electricity consumption to 20 per cent by Lithuania has introduced purchase promotion procedures (planned target volumes for electricity from renewable sources). To reach this target, the Law established annual production volumes (installed capacity and total generation), with the aim of reaching 1006 MW of renewable generation by Moreover, feed-in tariffs were introduced in 2002 and discounts for network connections of renewable energy power plants in In 2011, an auction system for generators larger than 30 kw was introduced. 3. STRATEGIC ORIENTATIONS 3.1. Transition challenges Lithuania is an advanced transition country, which implemented the EU body of market regulation prior to its EU accession in 2004 and which has benefited from integration into the EU internal market through substantial capital inflows and growing trade shares with the rest of the EU. The key remaining transition challenges are to reduce the energy intensity of the economy, particularly in the transport and residential sectors; build more effective institutions supporting the development of private equity to enhance financial intermediation to enterprises and foster the growth of risk capital; and deepen the market structure in the energy and infrastructure sectors and non-bank financial institutions. Figure 2: EBRD transition indicators for Lithuania,

15 3.2. Bank s priorities for the strategy period The EBRD s activities in Lithuania at present are limited and will remain focused on a small number of priorities, in line with the expected graduation of the country by the end of the current EBRD medium term strategy period in In light of this, the new Country Strategy for Lithuania will narrow the Bank s focus to specific objectives within three areas: infrastructure and energy, industry and commerce and financial institutions. The Bank does not expect to be active in all of these sectors, but will concentrate on opportunities among those, where the Bank s value-added is considered the highest and which provide a bridge to the Bank s anticipated postgraduation operational engagement in Lithuania Sectoral challenges and the Bank s operational response Infrastructure and Energy Sectoral challenges Energy intensity of Lithuanian GDP is about 2.5 times higher than the EU average and the government identified the largest potential savings in the transport and household sectors, i.e. residential property. Challenges remain in the facilitation of project development, especially in the housing and SME sectors. Although financial support systems for renewable energy are in line with EU practices, outcomes are lagging well behind. Private sector participation in municipal sectors remains low, particularly in the water and sewage, urban transport and state transport infrastructure. In line with the government s ongoing programme to promote public-private partnerships (PPPs), a challenge is to develop more projects in line with international best standards. Road maintenance companies could be privatised and become subject to performance-based contracts. Bank s operational response To strengthen energy security and improve energy efficiency, the Bank will support investments into renewable energy generation and energy security. The development of regional electricity connections (financed from other sources) will necessitate further investments in efficient and flexible energy generation. The Bank will support these and will promote energy efficiency related investments particularly in public buildings, utility companies and industrial enterprises. The EBRD will also seek ways to support investments in the residential building sector. To encourage private sector participation in infrastructure, EBRD will consider financing PPP projects and other innovative public-private financing initiatives in infrastructure (e.g. municipal services, port terminals). While this is expected to be limited in scope, the aim is to demonstrate possible ways to increase private sector delivery of public services, while remaining mindful of any increase in fiscal risks associated with such structures. Policy dialogue 14

16 Policy dialogue will support improvements to corporate governance in the public sector (e.g., the Bank s current dialogue with Lithuanian Post on the improvement of procurement practices) and, in line with the Lithuanian authorities requests, continue the dialogue concerning use of PPPs, in particular with regard to roads and other infrastructure Industry, Commerce, Agribusiness Sectoral challenges To sustain growth within this highly open economy there is an ongoing need to develop more technology-intensive sectors that are oriented towards export markets. Knowledge absorption could be raised not just through policies aimed at domestic innovation, though also through facilitating as yet inexperienced Lithuanian firms to establish a foothold in foreign markets, as outward investment remains as yet minimal. Bank s operational response To help enterprises expand and improve their competitiveness, EBRD will support cross-border investments of Lithuanian companies elsewhere in the EBRD region, providing a bridge to the Bank s anticipated post-graduation activities in Lithuania.In addition and selectively, the EBRD will consider a limited number of requests to support exporting enterprises, particularly in the knowledge-intensive segment of the economy or among those investing in advanced technology Financial Institutions Sectoral challenges Risk-oriented and long term capital are increasingly sparse within a banking sector that continues to adopt tight credit standards and reduce foreign liabilities. There is a need to further develop sources of equity capital outside the banking sector, such as private equity and venture capital. The failure of the mid-sized local bank Snoras and the ensuing (albeit brief) confidence crisis of depositors in similar institutions underlined the remaining vulnerability of the domestic banking sector. There is a need to enhance governance and the financial strength of local banks, possibly through assistance in consolidation. Bank s operational response To facilitate development of SME sector or innovation, the Bank will seek opportunities to invest in equity and mezzanine funds (most likely at a regional level) and ways to facilitate continued financing to the sector, including MSMEs. To support strengthening and consolidation of local banks, the Bank will consider, primarily through the EBRD s existing shareholding in Siauliu Bankas, opportunities to play an active role in the process of strengthening local banks, enhancing their 15

17 resilience, improving further their management and increasing their performance efficiency. Policy dialogue Policy dialogue in this sector will focus on banks corporate governance, supporting the priorities of the Lithuanian authorities, including development of the regulatory framework for co-operative financing institutions. The Bank will continue to work with the national authorities and the European Investment Fund to develop sustainable structures and financing models to facilitate the development of private equity and venture capital financing. A more liberal regulation of the allocation limits of domestic mandatory pension funds may support the objective of mobilising additional financing sources, and the Bank is already engaged in dialogue in this area Environmental and social implications of the Bank s proposed activities As a European Union member, Lithuania has adopted environmental and social legislation that is harmonised with the EU s acquis and is aligned with EBRD s Environmental and Social Policy and Performance Requirements. The Bank s Environmental and Social Policy will apply to all projects in Lithuania. The strategic focus on renewable energy generation as well as energy efficiencyrelated investments presents significant opportunities to reduce greenhouse gas emissions. In the infrastructure sector, public consultation and information disclosure will be an important part of project development. Health and safety will be an important consideration for the design and implementation of all EBRD projects. 4. ACCESS TO CAPITAL 4.1. Private sources of capital Over the course of the financial crisis Lithuania suffered a number of downgrades in its sovereign credit rating, primarily due to the growing risks to the long-standing currency board and the ramifications for the largely euro-denominated financial contracts. Currently, the main international credit rating agencies, Standard & Poor and Fitch Ratings, rank Lithuania s sovereign debt one notch above the speculative grade, BBB with a stable outlook. As in other countries in the region inflows of foreign direct investment remain well below the pre-crisis levels, last year at 2.9 per cent of GDP 2011, compared to over 5 per cent in Nevertheless, significant investment projects most notably commitments by Japanese engineering group Hitachi in the new nuclear power plant underline continued investor interest. 16

18 In line with excessive pre-crisis foreign funding banks in Lithuania continue to reduce external liabilities, last year at a rate of about 3 per cent of GDP. Consequently, commercial bank financing continues to be challenging. According to the most recent bank lending survey, covering the six months to April 2012, banks continue to tighten general lending conditions with regard to enterprises and significantly tightened them for housing loans. The largest impact on the stricter conditions was apparent in terms of higher requirements on collateral and contractual obligations, a more conservative assessment of loan maturities and higher non-interest charges. The main reasons determining the firm credit policy were banks high financing expenses and balance sheet constraints. The corporate loan stock has been continuously falling since late 2008 and has shrunk average of 8.5 per cent a year up to end The stock of household loans, on the other hand, continues to decline with an average annual pace of 5 per cent. Private equity, which could be instrumental in providing seed capital for young and innovative firms, remains underdeveloped. Fewer than five country dedicated and less than ten regional fund managers were identified for which the country was included in the investment scope MDB finance and cooperation with other IFIs and multilateral donors Lithuania is eligible for substantial amounts of EU funds, up to 6.7 billion. This consists of 40.5 per cent from the Cohesion Funds, 45.7 per cent from European Regional Development Fund and 13.8 per cent from European Social Fund. Lithuania s commitment rate is good: at end-may 2012 the commitment rate stood at 81.4 per cent, making Lithuania one of the leading countries in absorption of EU structural funds. Lithuania s repayment rate of 47.8 per cent is also among the highest in the EU. Other IFIs are clearly focused on the financial and infrastructure sectors, particularly energy related infrastructure, and emphasise large financings aimed at better rated borrowers. As a result, EBRD did not co-finance any projects with other IFIs in Lithuania during the previous strategy period. Over the last three years the European Investment Bank (EIB) has signed two loans totalling 24.5 million in Lithuania, in 2010 a 20 million loan with Lithuanian Railways to finance the purchase of freight locomotives and in 2011 a loan with Unicredit Leasing (Latvia) including 4.5 million to be used for the financing of SMEs in Lithuania. The European Investment Fund (EIF) has signed several commitments during the last four years under the EIF-managed JEREMIE Holding Fund initiative in Lithuania. Currently there are four banks implementing three types of debt instruments worth 118 million and four venture capital fund managers implementing equity-related transactions worth 57 million. In September 2012 the EIF (contributing 40 million) and the three Baltic countries (each contributing 20 million) signed the Agreements on the Baltic Innovation Fund. This is a fund of funds that will co-invest alongside private institutional investors (who will bring at least 50% of additional capital) in private equity funds operating in the Baltic countries, thus encouraging venture capital investments in small and medium-sized enterprises. 17

19 The Nordic Investment Bank (NIB) has signed four loans in Lithuania since end totalling 72.1 million, in 2010 a 20 million loan for City of Vilnius to finance the construction of a by-pass road, sludge treatment plant and renovation of schools and in 2011, also with the City, a 9.6 million loan to further finance the aforementioned by-pass, energy efficiency projects and the City s transport renewal programme. In June 2012 NIB signed a 34 million loan with Lithuanian Railways to modernise railway infrastructure and in July 2012 another loan of 8.5 million to the City of Vilnius to continue the financing of the transport renewal programme. Since the end of 2009 the Council of Europe Development Bank (CEB) has approved no new loans in Lithuania. Co-financing with other IFIs will be pursued in selected projects, mainly in infrastructure. Co-operation opportunities in PPP initiatives in relation to major infrastructure projects will be explored, if they arise during the strategy period, possibly related to projects funded by the EU structural funds. The Baltic Innovation Fund has been established in partnership with the EIF, and may offer opportunities for the Bank. 18

20 ANNEX 1 Political Assessment The Republic of Lithuania is committed to and applying the principles of multiparty democracy, pluralism and market economics in accordance with Article 1 of the Agreement establishing the Bank. Since the restoration of independence in 1990, Lithuania has made significant progress in building its democratic institutions. With an established track record of multiple peaceful transfers of political power between parties and coalitions, Lithuania s democratic political system can now be considered to be largely consolidated, although some challenges remain in the areas of public governance and the fight against corruption. Representative and Accountable Government Free, fair and competitive elections Elections in Lithuania at all levels are free, fair and competitive. Since the restoration of independence in 1990, Lithuania has held six parliamentary elections, five presidential elections, six local elections and two elections to the European Parliament. Domestic and international observers have consistently judged Lithuania s post-independence elections to be free and fair, although some concerns have been raised about the political bias of some media. Lithuanian elections have included a broad range of political parties representing a wide spectrum of political views, thus offering voters a genuine electoral choice. Both national and local elections have been highly competitive, and as a result elections at the national level have resulted in a regular alteration in power of centre-left and centre-right parties. Representative government that is accountable to the legislature and electorate Lithuania established a multiparty parliamentary democracy on the restoration of independence in The president, who is directly elected for a five-year term, is the head of state and is responsible for foreign and security policy. The president is also responsible for appointing the prime minister, who is approved by parliament and in turn appoints a cabinet, subject to presidential approval. Executive power is thus shared between the president and the prime minister, with the president responsible for the appointment of judges while the prime minister oversees domestic policymaking and the implementation of laws adopted by parliament. Since her election in May 2009, President Grybauskaitė has built on her large electoral majority and continuing high levels of popular support to play a more activist role in Lithuanian political life than that played by her predecessors. The Lithuanian Parliament (the Seimas) has 141 deputies elected for a four-year term, 70 of whom are elected on national party lists with a threshold of five per cent for parties and seven per cent for coalitions, and the remaining 71 in single-member constituencies elected in two-round majoritarian voting. The legislature is able to hold the Government to account through its approval of the Prime Minister, who in turn appoints the Cabinet. In addition, the Seimas is able to hold the Government to account through the mechanism of no confidence votes. The Government is also accountable to the electorate, first and foremost through the ballot box, but also 19